Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach

41 Pages Posted: 31 Jan 2011 Last revised: 4 Feb 2011

See all articles by Jon Faust

Jon Faust

Board of Governors of the Federal Reserve - Division of International Finance; Johns Hopkins University

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Jonathan H. Wright

Johns Hopkins University - Department of Economics

Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs

Multiple version iconThere are 2 versions of this paper

Date Written: January 2011

Abstract

Employing a large number of real and financial indicators, we use Bayesian Model Averaging (BMA) to forecast real-time measures of economic activity. Importantly, the predictor set includes option-adjusted credit spread indexes based on bond portfolios sorted by maturity and credit risk as measured by the issuer's "distance-to-default." The portfolios are constructed directly from the secondary market prices of outstanding senior unsecured bonds issued by a large number of U.S. corporations. Our results indicate that relative to an autoregressive benchmark, BMA yields consistent improvements in the prediction of the growth rates of real GDP, business fixed investment, industrial production, and employment, as well as of the changes in the unemployment rate, at horizons from the current quarter (i.e., "nowcasting") out to four quarters hence. The gains in forecast accuracy are statistically significant and economically important and owe exclusively to the inclusion of our portfolio credit spreads in the set of predictors--BMA consistently assigns a high posterior weight to models that include these financial indicators.

Suggested Citation

Faust, Jon and Gilchrist, Simon and Wright, Jonathan H. and Zakrajsek, Egon, Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach (January 2011). NBER Working Paper No. w16725. Available at SSRN: https://ssrn.com/abstract=1749886

Jon Faust (Contact Author)

Board of Governors of the Federal Reserve - Division of International Finance ( email )

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Simon Gilchrist

Boston University - Department of Economics ( email )

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Jonathan H. Wright

Johns Hopkins University - Department of Economics ( email )

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Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs ( email )

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